Sign up today for an exclusive discount along with our 30-day GUARANTEE — Love us or leave, with your money back! Click here to become a part of our growing community and learn how to stop gambling with your investments. We will teach you to BE THE HOUSE — Not the Gambler!

Click here to see some testimonials from our members!

The VIX Will Tell Us If The S&P Is In A Bubble

Courtesy of ZeroHedge View original post here.

Submitted by Nicholas Colas of DataTrek Research

There is growing concern that US stocks are replaying the tech-driven bubble phase of the late 1990s. Today’s S&P rally fits that narrative. The CBOE VIX Index will tell us if it will be our fate to live through 1999 again. Back then, the VIX generally held above 20. In every other sustained rally back to 1990, it went below 20 and generally stayed there for years.

Just one “Markets” topic today: the CBOE VIX Index. The mathematical mechanics of the VIX are grimy, of course. To the letter of the law, it is the implied volatility priced into short term options on S&P futures contracts. Metaphysically, the VIX is the one variable in the Black-Scholes pricing model you can’t measure elsewhere but rather the number that falls out of the equation once you plug in asset and strike prices, interest rates and time to expiration.

But the world simply knows it as the Fear Index… When the VIX is rising quickly you can be sure stock prices are likewise falling. And when the VIX is heading lower after a spike, you know the S&P is recovering from a recent drop.

And that’s where we find ourselves today: the VIX declined to 24.46 and the S&P rallied to 3,252, respectively a post-COVID Crisis fresh low and high. And if one looks at the VIX’s long run distribution of observations, there would seem to be reason to think the rally can continue:

  • The average of all CBOE VIX closes back to its start in 1990 is 19.4.
  • The standard deviation of the VIX over that time is 8.1 points.
  • At today’s 24.46 VIX level we’re well within 1 standard deviation (27.5 being the upper band), indicating that the options market thinks we are not set up for another bout of market volatility in the near future.

As comforting as that message may be, we need to acknowledge that Monday's breakout in the S&P and correlated break down in the VIX was entirely due to the Tech sector plus Facebook/Google (Communication Services) and Amazon (Consumer Discretionary). No other industry groups were in the green. US mid-caps and small-caps also ended the day lower.

There was, of course, another period in market history with similar fundamentals, so let’s look at the VIX across multiple cycles to see what we can learn. The chart below shows monthly VIX data back to 1990, with the January 2000 VIX level highlighted as a way to focus our attention on this potentially analogous historical period.

In this 30 years of VIX history we see 3 things that are relevant to understanding today’s US equity market:

  1. Put aside the idea that US equities can only rally in a sleepy, grinding way once a crisis has passed. This is the most common pattern, to be sure; look at how the VIX chart makes a smile shape through every market cycle. But it isn’t the only way stocks rally…
  2. Instead, focus on what happened from 1997 – 2000; that’s why we highlighted January 2000’s 24.95 average level. This was a relatively unusual period of market history, with higher than average VIX readings (reliably above 20) pairing up with stellar S&P 500 returns (1997 +33.1%, 1998 +28.3%, 1999 +20.9%).
  3. Consider how similar the setup in 2020 is to the 1997 – 2000 time period, except that now a handful of very profitable Big Tech companies dominate important verticals and provide market leadership rather than the free-for-all that drove stock prices higher during the late 1990s dot com bubble.

We totally understand why this is not necessarily a welcomed interpretation of current market psychology. It does, however, fit the facts and it certainly describes the S&P’s break out on Monday anchored purely on Big Tech’s strength. There have been 10 turns of Moore’s Law since the year 2000, but those in conjunction with the disruption wrought by COVID-19 may finally be delivering the tech-driven world many imagined in 1999.

The good news is that the VIX will tell us if we’re in another speculative bubble, because if that’s the hand we have to play we will see the Fear index stay mostly above 20. This won’t be a sell signal, just as it wasn’t in 1997. But it will be a sign that we’re in a different sort of market from the ones we usually see after a crisis.


Do you know someone who would benefit from this information? We can send your friend a strictly confidential, one-time email telling them about this information. Your privacy and your friend's privacy is your business... no spam! Click here and tell a friend!





You must be logged in to make a comment.
You can sign up for a membership or get a FREE Daily News membership or log in

Sign up today for an exclusive discount along with our 30-day GUARANTEE — Love us or leave, with your money back! Click here to become a part of our growing community and learn how to stop gambling with your investments. We will teach you to BE THE HOUSE — Not the Gambler!

Click here to see some testimonials from our members!